What is my option?
Why am I paying an "Option Fee" and what is it for?
If you have ever bought a home in Texas you are probably familiar with the terms "Option Fee" and "Option Period". But do you know what they mean and why you paid that fee? I will attempt to break it down so that this often confusing concept becomes clear as day.
One of the most impactful parts of the Texas residential sales contracts is Paragraph 5. This paragraph is long and has a number of items in it, but we will only be discussing part of that paragraph today. Section A states "Within 3 days after the Effective Date, Buyer must deliver to (Escrow Agent) ______ as the Option Fee."
Section B then states "For nominal consideration, the receipt of which Seller acknowledges and Buyer's agreement to pay the Option Fee within the time required, Seller grants Buyer the unrestricted right to terminate this contract by giving notice of termination to Seller within ______ days after the Effective Date of this contract (Option Period)." Boy is that a mouthful.
Your REALTOR® should consult you on this fee and the time period and explain the ramifications. But that doesn't always happen so we are going to break it down for you.
Inspection Contingency or Due Diligence Period?
Other states have different rules and laws regarding inspections and their contracts have different provisions on what is allowed and what isn't allowed. I have often heard people in other states refer to this as Inspection Contingency or Due Diligence Period. Texas has neither one of these in its residential sales contracts. Instead, Paragraph 5 outlines a blanket termination option. This means that during the specified timeframe, the buyer can terminate the sale for ANY REASON whatsoever. In fact, they don't even have to give a reason. That is what Paragraph 5 lays out. By using the term "unrestricted right to terminate" the buyer is allowed to walk away from the purchase. They will receive their Earnest Money back and are free to move on to another house or not purchase anything.
This Option Period essentially acts as a Inspection Contingency or Due Diligence Period. The buyer will typically use this time period to complete any inspections they require. They might also use the time to firm up their financing. Or maybe they will continue to shop houses in case a better comes along, although I recommend against this.
How much is the option fee?
The option fee amount is negotiable. The contract has a blank for the amount. So what is a reasonable amount? Well that depends and is constantly changing. When I got started in this business the amount was most commonly $100. By paying $100 you could have full purchase rights for a number of days. The sellers couldn't sell to anyone else that came along even if they offered more. The buyers, on the other hand, were able to walk away whenever they felt like it and all the sellers would have to show for their lost time was $100. Not very fair to them.
Shortly after I started, the market started to heat up. The 2008 recession was officially over and we entered a sellers market for the first time in several years. We quickly saw the option fee rise. Now $200 or $250 were pretty common. In a multiple offer scenario we would maybe see $500 or so but that certainly wasn't the norm.
Everything changed in early 2020. COVID-19 led to a run on real estate. We saw crazy bidding wars. For the next 2 years we saw $500 becoming pretty normal. With the bidding wars some buyers began offering insane option fees. $1,000 was not uncommon but $2,000 wasn't unheard of. Heck, I even heard of some cases of buyers offering $10,000. To me that is just crazy. I would never recommend that to a client. The option fee is completely NON-REFUNDABLE. If the buyer cancels they don't get this back. If they find out the house has mold or the foundation is collapsing they don't get that money back. Typically, I think an option between $200 and $500 is sufficient depending on the situation.
The length of the option period is again open for negotiation. It has traveled in the reverse of the option fee. As the option fee went up, the days typically went down. Again, back when I started 10 days was pretty standard. It shortly thereafter changed to 7 days or maybe 5 in a multiple offer situation. In the pandemic market we saw this often dropped to 3 days or even less.
When I am writing an offer for a buyer I often base the length on days of the week. I don't like to spend my weekends and holidays negotiating repairs. As such, if I am writing an offer on a Saturday and I put 7 days for the option period, I know that I will probably spend my next weekend negotiating. Instead I will shift the days to either end on Friday or on Monday depending on the circumstances. I will also make note of that when I deliver the offer to the seller's agent since they will likely appreciate that forethought.
One thing to note is that Paragraph 5 Section B states "Notices under this paragraph must be given by 5:00 p.m. (local time where the Property is located) by the date specified. This means that the option period ends at 5pm on the last day, not at 11:59 pm. When determining contract dates, it is important to note that the day the contract is fully signed by everyone (executed) is day zero. For instance, if buyers and seller sign the contract on the 5th of August, then the 6th is day 1, the 7th is day 2 and so on. So if the option period is 7 days, the option period would end at 5 pm on the 12th of August.
Is there always an option period?
Sometimes buyers will forgo the option period in a multiple offer situation. While some may think this is foolish, there are often other contingencies that can take the place of the option period. Things such as financing contingencies, seller disclosure notices and HOA documents can allow the buyer plenty of time to have an out without needing to pay the option fee. A good seller's agent will negotiate to remove as much of these as possible, but a good buyer's agent will try to keep them in.
Another thing to keep in mind is the time period to deliver the option fee. If you look back at Section A of Paragraph 5 it states "Within 3 days after the Effective Date, Buyer must deliver to (Escrow Agent) ______ as the Option Fee." As I mentioned before, the effective date is day zero so you have 3 days to deliver this to the escrow agent. Paragraph D then states "FAILURE TO TIMELY DELIVER OPTION FEE: If no dollar amount is stated as the Option Fee or if Buyer fails to deliver the Option Fee within the time required, Buyer shall not have the unrestricted right to terminate the contract under paragraph 5." So if you don't get it delivered in time, then you don't have an option period. Another little tidbit in that is that the buyer MUST pay a fee in order for them to have an Option Period. I have occasionally been told by seller's agents that the seller doesn't want an Option Fee but the buyer can still have the Option Period. This is very common with institutional sellers and relocation companies. So while the sellers may not want the fee, there MUST be one in order for the buyer to have the right to terminate.
Hopefully you now have a better understanding about the Option Fee and Option Period. If not, please reach out to us and we can answer any questions you might have. Whether you chose to work with us or another brokerage, make sure your next REALTOR® understands the in's and out's of this vital part of the Texas residential real estate transaction.